How is Economic Inequality Defined?

The Equality Trust’s Focus on Economic Inequality

Economic inequalities are most obviously shown by people’s different positions within the economic distribution - income, pay, wealth. However, people’s economic positions are also related to other characteristics, such as whether or not they have a disability, their ethnic background, or whether they are a man or a woman. While The Equality Trust recognises the importance of these measures, the focus of our work is specifically the gap between the well-off and the less well-off in the overall economic distribution. This is reflected in the choice of terms and statistics in this section.

There are three main types of economic inequality:

1. Income Inequality

Income inequality is the extent to which income is distributed unevenly in a group of people.

Income

Income is not just the money received through pay, but all the money received from employment (wages, salaries, bonuses etc.), investments, such as interest on savings accounts and dividends from shares of stock, savings, state benefits, pensions (state, personal, company) and rent.

Measurement of income can be on an individual or household basis – the incomes of all the people sharing a particular household. Household income before tax that includes money received from the social security system is known as gross income. Household income including all taxes and benefits is known as net income1.

2. Pay Inequality

A person’s pay is different to their income. Pay refers to payment from employment only. This can be on an hourly, monthly or annual basis, is typically paid weekly or monthly and may also include bonuses. Pay inequality therefore describes the difference between people’s pay and this may be within one company or across all pay received in the UK.

3. Wealth Inequality

Wealth refers to the total amount of assets of an individual or household. This may include financial assets, such as bonds and stocks, property and private pension rights. Wealth inequality therefore refers to the unequal distribution of assets in a group of people.

How is Economic Inequality Measured?

There are various ways of measuring economic inequality. The choice of measure does not change what inequality looks like dramatically2. However, changes in inequality over time within individual countries can look different if different measures are used3,4.

Commonly used measures of economic inequality:

1. Gini Coefficient

The Gini coefficient measures inequality across the whole of society rather than simply comparing different income groups.

The UK's Gini is 0.35.

If all the income went to a single person (maximum inequality) and everyone else got nothing, the Gini coefficient would be equal to 1. If income was shared equally, and everyone got exactly the same, the Gini would equal 0. The lower the Gini value, the more equal a society.

Most OECD countries have a coefficient lower than 0.32 with the lowest being 0.24. The UK, a fairly unequal society, scores 0.35 and the US, an even more unequal society, 0.38. In contrast, Denmark, a much more equal society, scores 0.255.

The Gini coefficient can measure inequality before or after tax and before or after housing costs. The Gini will change depending on what is measured.

2. Ratio Measures

Ratio measures compare how much people at one level of the income distribution have compared to people at another. For instance, the 20:20 ratio compares how much richer the top 20% of people are, compared to the bottom 20%.

Common examples:

50/10 ratio – describes inequality between the middle and the bottom of the income distribution

90/10 – describes inequality between the top and the bottom

90/50 – describes inequality between the top and the middle

99/90 – describes inequality between the very top and the top

3. Palma Ratio

The Palma ratio is the ratio of the income share of the top 10% to that of the bottom 40%. In more equal societies this ratio will be one or below, meaning that the top 10% does not receive a larger share of national income than the bottom 40%. In very unequal societies, the ratio may be as large as 7.

The Palma ratio addresses the Gini index's over-sensitivity to changes in the middle of the distribution and insensitivity to changes at the top and bottom6.

The UK Palma ratio is 1.07.

The Palma ratio is commonly used in international development discourse. The ratio for Brazil, for example, is 2.237.

What is Poverty and How is it Different to Inequality?

People in poverty are those who are considerably worse-off than the majority of the population. Their level of deprivation means they are unable to access goods and services that most people consider necessary to an acceptable standard of living8.

It can be an absolute term, referring to a level of deprivation that does not change over time, or a relative term in which the definition fluctuates in line with changes in the general living standard.

The most commonly used definition of poverty in the UK is a relative measure: poverty is defined as having a household income (adjusted for family size) which is less than 60% of median income. This is one of the agreed international measures used throughout the European Union.

Inequality, by contrast, is always a relative term: it refers to the difference between levels of living standards, income etc. across the whole economic distribution. In practice, poverty and inequality often rise and fall together but this need not necessarily be the case. Inequality can be high in a society without high levels of poverty due to a large difference between the top and the middle of the income spectrum.

[1] This section mainly shows differences in household incomes. The section mainly uses gross household income. Where tax has been taken into account the graph will specifically state that it is looking at net income rather than gross. Gross is mainly used as this is the predominant focus in the economic inequality literature which is discussed elsewhere on the The Equality Trust guide to inequality.

[5] Income inequality is measured as household disposable income in a particular year. It consists of earnings, self-employment and capital income and public cash transfers; income taxes and social security contributions paid by households are deducted. The income of the household is attributed to each of its members, with an adjustment to reflect differences in needs for households of different sizes. Results refer to income in 2008 in the UK and US and 2007 in Denmark. (OECD Factbook 2011)